Dissecting coronavirus economic impact and recovery options

HOW DO WE AVOID a disastrous humanitarian crisis in developing countries as we emerge from the pandemic lockdowns? Will economic justice be harder or easier to attain after COVID-19? How do we get our nation back to work? Should we focus on the surging federal debt?

We asked several faculty members at Harvard Kennedy School for their insights on the central economic challenges as the United States and the world shift toward the recovery phase of the crisis. The ideas these scholars offered can assist political leaders and administrators who are making policy decisions at the federal, state, and local levels.

Jump to:

• David Deming on preserving jobs as a top priority
• Karen Dynan on worrying less about federal debt than fiscal support
• Chris Avery on fixing models that predict pandemic victims
• Linda Bilmes on local government and small business choices
• Amitabh Chandra on putting health care capacity first
• Rema Hanna on social protection for the most vulnerable
• Carmen Reinhart on how banks should deal with nonperforming loans
• Dani Rodrik on how the pandemic will shift the focus to economic justice

Best path to reviving job market is preserving existing jobs

The Coronavirus has caused the worst employment crisis in the United States since at least the Great Depression. Since late March, 33. 5 million Americans have filed for unemployment insurance. To put this in perspective, more Americans have lost jobs in the last six weeks than in the previous two-and-a-half years combined. Economists estimate that the unemployment rate right now is between 15 and 20 percent, by far the highest we’ve seen since the years before World War II.

How can we get our nation back to work? First—before anything else—we must solve the public health crisis by halting the spread of COVID-19. Whether lockdowns officially continue or not, the economy will not recover until people feel it is safe to engage in commerce. Decisions we make now about how to support employers and workers through the crisis will determine how quickly we can recover in the aftermath of this global pandemic.

The best way to get the nation back to work is to preserve existing jobs. All of the relationship-specific capital that is developed in an employer-employee match gets destroyed in a job separation, and this can be very costly (think about how much you’ve learned since your first day on the job, and the cost of developing that knowledge again from scratch). The CARES Act stimulus bill created the Paycheck Protection Program (PPP), which provides forgivable loans to small businesses that maintain payroll. PPP’s goal was to preserve existing jobs. But as the crisis goes on, small employers will go out of business entirely, and employees will move on to other opportunities in order to keep food on the table.

The second-best approach is to support jobseekers as they make difficult transitions into new jobs and careers. Two types of support are necessary. First, we must continue to extend and expand unemployment insurance benefits. The CARES act made unemployment insurance (UI) much more generous, expanding weekly benefits by $600. However, this lasts only until July 31. There is almost no chance that the crisis will be over by then. I don’t know when the economy will get back to normal, and neither does anyone else. Which is why Congress should authorize the use of automatic triggers for UI benefit extension, rather than setting arbitrary deadlines. One recent proposal calls for UI benefit extensions to last as long as we are in a declared state of public health emergency.

Second, we must lower hiring costs and give workers a boost out of unemployment. There are lots of good ideas out there, ranging from apprenticeship programs to employment subsidies to public service job guarantee programs. Each of these policies might seem heavy-handed during normal times. But we must think big if we are going to stave off the coming jobs crisis.

David Deming is Professor of Public Policy and Director of the Malcolm Wiener Center for Social Policy, HKS; and Professor of Education and Economics, HGSE.

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Worry later about the federal debt. Fiscal support comes first.

The fiscal support put in place to cushion the COVID blow to the U.S. economy—and the additional measures that are likely to come—are leading to a sharp jump in the federal deficit. Based on just the measures enacted to date, the ratio of federal debt to GDP is projected to rise above 100 percent by the end of September. The only previous time in the history of this country that this ratio reached such a high level was during World War II. However, passing that historical mark does not mean that we should worry about federal borrowing immediately. Instead, we should start worrying about debt when government interest rates rise considerably above their current levels.

Waiting is appropriate both from the perspective of prudent budget management and from the perspective of when the U.S. economy will be strong enough to withstand the withdrawal of fiscal support. Now is not the time to be concerned. The sharp weakening of the economy in March led to a drop in interest rates that reinforced a decades-long downtrend. The yield on 10-year Treasury notes has been well below 1 percent in recent weeks, compared with an average of 4.5 percent over the last three decades. Depriving the U.S. economy of the fiscal support it needs now would both increase the suffering of the most vulnerable Americans and threaten the economic recovery. Even trying to make plans now for eventually reducing deficits would be a mistake, as it would divert attention from the critical policy issues we face now.

Karen Dynan is Professor of the Practice of Economics, Faculty of Arts and Sciences, Harvard University.

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Recovery hinges on predictive modeling of pandemic victims

The predictions of various epidemiological models of the spread of COVID-19 vary widely for three related reasons. Understanding these reasons is of vital importance to policymakers who are planning strategies to get us through the pandemic and in position for a successful recovery.

First, the rate of spread of the epidemic depends on human behavior, in particular the degree of “social distancing” practiced in each location. An initial projection of more than 2 million deaths in the United States that received a lot of publicity in mid-March was clearly an overestimate because it was based on the assumption of no additional precautionary behavior as the disease spread. On the other hand, a subsequent projection of the well-known IHME model of 60,000 deaths in the United States was clearly an underestimate because it assumed that the response in the United States would be similar to that of Wuhan, China, where the government enforced a very strict lockdown.

Second, there has been no systematic random testing, which means that we don’t know the true rate of infection and for the same reason, we don’t know the true mortality rate for those who contract the disease. A recent antibody test suggests that 20 percent of New York City residents have been exposed to coronavirus—nearly 10 times the percentage who have tested positive for COVID-19.

Third, since infectious diseases grow initially at an exponential rate, small changes in behavior, such as an early start to a lockdown period, can have large-scale effects on long-term outcomes. Similarly, predictive modeling is a very delicate exercise, as seemingly minor assumptions can have considerable influence on resulting outcomes.

Christopher Avery is the Roy E. Larsen Professor of Public Policy.

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State and local governments can lead the recovery

State and local governments provide essential services such as schools, water, sewerage, trash collection, public transit, police, fire, and emergency medical care. They face an immediate liquidity crisis and a long-term revenue shortfall due to declining tax revenues, user fees and grants, as well as new headwinds in the municipal bond market—a “perfect fiscal storm.” Unlike the federal government, states must balance their budgets. It took them five years to recover from the 2008 financial crisis. This time will be even worse. The Congressional Budget Office predicts that their collective budget shortfall over the next three years will reach $650 billion—twice the size of 2008. States receive about 45 percent of their revenue from income taxes and the rest from sales and other taxes and fees. But there is a great deal of variation among the states, depending on their financial condition pre-COVID-19 and their mix of revenue streams. Louisiana and Florida, for example, will be especially hard hit due to their heavy dependency on sales taxes, underfunded pension obligations, and low level of reserves. Local governments, including cities, towns and counties, face significant reductions in the amount of aid they receive from the states.

Such intergovernmental transfers account for 40 percent of their revenues. In 2008, cities compensated for this shortfall by raising revenues from property taxes, sales taxes, and fees. This time is completely different, and they don’t have many options. Raising property taxes or increasing tolls, parking fees, or airport landing charges is unlikely to yield significant revenue given there is less travel—but it will pile more pressure on the local economy, thereby jeopardizing the future tax base.

Local governments also face a more difficult borrowing environment. For the past decade, cities have enjoyed easy access to the municipal bond market at low interest rates to finance capital improvements such as roads and bridges. However, the bond market has changed overnight, as bond investors view the new financial risks facing cities. Even if local governments do manage to retain their bond ratings, it will be more difficult and expensive to raise fresh capital.

Local governments are also the front line in terms of helping small businesses, which are the lifeblood of their communities. The federal stimulus has provided a bridge to help small businesses stay afloat for about three months, but restaurants, hairdressers and car repair shops don't have the ability to survive for long without customers. Even if federal government enacts a further stimulus targeted to state and local governments, it won’t be sufficient to prevent painful cuts at the local level.

Given these extraordinary circumstances, what can local governments do?

First, like doctors, they should do no harm. For their operating budgets, instead of across-the-board cuts and layoffs to reduce spending, cities should use an activity-based approach. Activities within each department must first be reviewed and those with lower priority can be reduced or eliminated, rather than across-the-board cuts. Convening a local control board can assist in making difficult trade-offs.

Second, communities need to adjust the way they budget, planning at the outset for a worst-case scenario, then examining variances on a monthly basis and adjusting the budget as new information comes in.

Third, local governments need to defer non-essential capital spending and, where possible, refinance outstanding debt at lower interest rates. To lay the groundwork for recovery, retaining access to capital markets should be a priority and mayors should engage with their investor community to show they have a plan to keep their finances under control. In Massachusetts, State Treasurer Steve Grossman successfully shifted $4 billion in state bond holdings from Wall Street to Main Street, seeding community banks, which in turn helped to revive communities after 2008. This should be a role model for states and cities this time around.

Linda Bilmes is the Daniel Patrick Moynihan Senior Lecturer in Public Policy, HKS.

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States should reopen only if healthcare systems are ready

A decline in cases only means that the quarantining was successful, not that the virus has been vanquished. In general, I do not believe that we are ready to reopen the economy for we have not made the necessary investments to ensure that the reopening will be safe. Reopening the economy responsibly depends on three constraints—health care capacity, testing capacity, and contact-tracing capacity—which vary by state and time, but do not depend on the condition of the economy. This may seem strange, but the economy will be even worse if it is restarted prematurely, which, in turn, means that a pre-specified or national date for reopening the economy should be avoided. It is also true that a responsible opening is within our technological grasp, but in general, we have not made the adequate investments in it.

One condition for reopening is to determine whether health systems in specific regions have the resources and personnel available to deal with smaller but inevitable second waves of disease. Reopening does not work if the delivery system is stretched to capacity or beyond, and some communities will be unable to open because of limited capacity. This is a necessary condition for reopening, but it is not a sufficient condition. The latter requires us to provide more tailored guidance on who should remain quarantined and what activities—say sporting events—should remain shuttered.

Finally, the frontline essential workers—nurses, doctors, health workers, law-enforcement, transportation workers, and grocery store workers—and their families are tired, and we should not assume that they are automatically ready for a reopening of the economy. Thinking about their well-being—through direct cash transfers or insurance—is a vital determination that we should not ignore.

Amitabh Chandra is the Ethel Zimmerman Wiener Professor of Public Policy, HKS, and Henry and Allison McCance Professor of Business Administration, HBS.

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Avoiding a widespread humanitarian crisis requires a global economic and financial intervention not seen before.

COVID-19 is not only a health crisis. It is an economic crisis, whose impacts will persist long beyond the immediate lockdown periods. The World Bank estimates that the pandemic will push about 50 million more people into extreme poverty. This has the potential to roll back decades of progress made in global poverty alleviation.

Large-scale government intervention is needed to prevent widespread hunger and desperation. Governments in developing countries must act quickly to expand the coverage and scope of social protection: cash transfers, health insurance, food distributions, active labor market protections.

People who have not received social protection before will need immediate access. This means governments need to introduce flexible enrollment systems—e.g. community information systems, on-demand enrollments, administrative data verification—wherein the newly vulnerable and jobless can get assistance.

The type and extent of the increases in assistance will depend on the local needs of each country: the severity of a country’s economic shocks, the existing social assistance in place, and the spread and severity of the health crisis. For example, the evidence suggests the efficacy of cash transfers over in-kind distributions. Yet, if lockdowns exacerbate supply shortages, short-run, localized food distributions may be necessary. Increased real-time monitoring data is, thus, needed to help better adjust programs based on local economic conditions.

All of this will take increased financing. While the World Bank and International Monetary Fund have undertaken measures to help, the international community needs to step up further to prevent a widespread humanitarian crisis.

Rema Hanna is Jeffrey Cheah Professor of South-East Asia Studies, HKS.

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How we handle bad debts will determine success of economic recovery

While the coronavirus crisis did not start as a financial crisis, it may well morph into one of systemic severity. At the start of 2020, U.S. banks were better capitalized and household balance sheets stronger than at the onset of the global financial crisis in 2008. As COVID-19 paralyzed activity, banks have taken measures to protect themselves, increasing loan loss provisions and making accommodations to borrowers. Banks’ mortgage loan forbearance efforts, which are backed by the CARES Act, for instance, provide relief to households hit by the loss of income and employment.

Notwithstanding support from new Federal Reserve facilities, the critical question facing financial institutions is whether borrowers are ultimately able to meet the terms of the loans once the “grace period” ends. The answer depends critically on the duration of the pandemic and the speed of economic recovery. Even in a benign scenario, the damage already done to the balance sheets of banks, households, and businesses is substantive. Not all jobs will return and not all businesses will be able to reopen. A spike in defaults as 2020 unfolds is in the making. The historical experience with banking crises resolution suggests that a prompt and accurate acknowledgement of losses is the first step to a speedier recovery. Evidence suggests that kicking the can down the road in writing down bad debts may impair the effectiveness of monetary policy. In much of post-2008 Europe, the ever-greening of non-performing loans was a significant deterrent to the new credit needed to rekindle the economy. Let us avoid that mistake.

Carmen M. Reinhart is the Minos A. Zombanakis Professor of the International Financial System, HKS.

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The pandemic will shift our focus to economic justice

Economic justice will be more attainable after COVID-19 for the simple reason that there will be much greater public demand for it. The crisis has laid bare the vast inequalities that plague the American economic system. I predict we will see higher levels of grassroots mobilization in favor of universal health insurance, expanded public support for education, increased worker voice and power in the workplace (including in the gig economy), greater public control over large high-tech firms and big data, and assistance to lagging regions. The political system will have to respond—even if not quickly, eventually.

Fiscal resources will be in short supply, in light of the steep rise in public debt the present crisis will necessitate. But the main obstacle to economic justice in the United States has never been fiscal or financial. Progress has been slow because of the failure of political elites (including those on the liberal side of the spectrum) to overcome their attachment to the established economic order and to contemplate institutional reforms that would prioritize inclusion and economic security. The pandemic makes it much harder to sustain the illusion that all that we need is to return to the pre-Trump status quo ante.

Dani Rodrik is the Ford Foundation Professor of International Political Economy, HKS.

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Customers ride an escalator at a shopping mall in Houston, Texas after it reopened May 1st during the COVID-19 outbreak.

Banner photo by Adrees Latif; faculty portraits by Martha Stewart.